Sunday, October 16, 2016

Being Long is Worth the Bet -
Despite Consensus


Consensus turns out to be correct occasionally. As  alluded to in last week's post, published bookmakers’ odds are simply the ratio of the amount of money bet on a particular horse, issue, or perhaps someone running for election. There is often a big difference in the confidence expressed by aggregate money and the probabilities of success. Even to themselves (let alone to any third party) voters rarely say why they voted the way they did. After many political elections the people who claim that they voted for the eventual winner is significantly higher than the recorded reality. It is not my professional function to guess which way an election will turn out and history suggests it may not matter as events that take place after the election will determine the enacted policies.

As a professional investor and portfolio manager for institutional and high net worth clients, the essence of my job is to make reasonable judgments about the future course of markets; first to reduce the chances of meaningful capital losses and second to increase the opportunities to grow capital. Notice I phrase my tasks in terms of chances. In other words, I focus on the odds. Thus, one can see why I believe my early exposure to going to the racetracks was instructive. At the time the New York tracks offered the most in prize money and therefore probably had not only the best horses running but also the savviest bettors.  (This was good training for future competition in picking stocks and funds.) At the track the amount of money bet on a particular horse identified the favorite of the betting crowd's dollars. In other words the favorite was the consensus bet. There were two problems with betting on the favorite. Roughly they win only about a third of the time. More importantly the winning payoff from favorites rarely covers more than one losing bet and often not enough to bring the losing bettor to break even. As we all are driven by our own experiences and hopefully those of accepted others, I do not favor consensus bets for investments.

Reading the Consensus is Useful

One of the important investment lessons is that to be successful is to be dependent on someone else to buy your merchandise at a high price. Thus, it is critical to understand the motivation of other investors. By definition many investors are guided by the consensus. 

If one reads what most of the pundits are saying they are more concerned about the present risks than opportunities. This is understandable in view of slow growing or contracting economies with declining productivity, political uncertainties globally, and low nominal manipulated interest rates. A number of market analysts are flashing danger or at least caution signs and reminding us as to the current length of the bull markets.

Consumers are worried about their own economic future. With the mix of population growing older some people may be worried that their retirement capital is insufficient. (Long-term this could be a positive for the investment segment of the market.)

Missing Opportunities from the Past

Going back to the horse racing analysis, longer races allow for temporary recoveries and tend to favor higher quality horses. The same is generally true with investments. In his recent blog,  Bill Smead of Smead Capital published the following chart:
S&P 500: 1926- 2015

Time Frame
% Positive
% Negative
1 Year
5 Years
10 Years
20 Years

Two worthwhile items to note. The first is that the table is just expressed in gains and losses and their size. The second is that historical experience supports our concept of the TIMESPAN L Portfolios ® . We assume that the shorter term portfolios will produce more cyclical performance and the longer term portfolios will show more secular growth.

One attempt size the positives and negatives is this week's Barron's Big Money Poll. Among other questions, one asked what were the chances that the S&P500 would reproduce its long-term performance of approximately 9% per year?  Of the responses, 80% felt that it would not produce this return over the next five years, but 44% of the participants felt that over ten years the index would also underperform. The implication is that the aggregate group is looking for an acceleration in growth in the second five year period.

My Guess

With so many people being worried about the outlook, particularly the near term, I believe there is not a great deal of risk in terms of the permanent loss of capital by remaining long this equity market. I am somewhat comfortable accepting that there can be intermediate price declines of up to 25%. Over the next five to twenty year periods mentioned, there are upside potentials of multiple doubles. Thus it is worth the bet.


For those that attempt to use any particular day to trade rather than a long series, be careful about intraday trading. Currently on many days the pattern of trading is similar to those that my grandfather knew. This view is reinforced when one looks at the number of floor traders working orders at trading posts on the floor of the New York Stock Exchange as shown on cable television. They are busy on the opening and closing. For periods in between, I suspect they are active in off-floor trading with institutions. The opening benefits from orders from Europe which often means more buying than selling as long as the US dollar is rising in value. (I do not expect that the trend to continue.) I have noticed that unless the market is strong at the end of the day, often the gains of the session are reduced as traders want to lessen their exposure overnight.  Investors should be conscious as to the timing and methods of placing orders as it is an important skill in this period of low returns. One of the advantages of using mutual funds as the medium of investment is that orders for fund shares are executed on a forward basis meaning that execution price will be the price of the net asset value on the close.

In Conclusion

Use consensus not as a guide but as a recipient of your investments. Relax through periodic declines. The odds favor the long-term investors.

Copyright © 2008 - 2016
A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

Sunday, October 9, 2016

Searching for Confidence


If we were more confident, we would commit. The lack of confidence is what prevents us to committing to another person, a political view and an investment of time, effort, or money.  Animals as well as humans over-rely on our or others' memory as a guide for our next committed actions. The difference between humans and animals is that out of bitter experience we have been disappointed that in particular cases the past was not repeated exactly as believed.

To protect ourselves from disappointment we search for systematic ways to predict the future. Often not finding the magic formula, we rely on so-called "experts."

Another Lesson from "The Track"

While at the track after I concluded either I couldn't find the next winner or in my opinion the betting odds were too low to make a sound bet, I began a life-long exercise. I listened to those around me in their conversations as to why they thought a particular choice was the correct one. In an over-simplification, these views generally fell into two camps. The first very much focused on especially current information about various horses, jockeys, trainers, times of prior winners, and track conditions. The second camp used various numerical inputs such as past speed records for the race, the weight the horse was carrying, whether horses that were favorites that day were winning at the expected rate, etc, etc. This second group was slavishly following a systematic procedure or as it was known at the track, they had a system.

The post-race reactions after members of each camp that did not win was most instructive. First both blamed various "experts" for not producing winners for them. Those in the first camp restudied the information they had before the race to see what critical insight that they missed that they should apply to future races. The second camp’s followers rechecked their data for accuracy and if their math was correct they would begin the search for a new system and a new set of "experts."

The first camp were my first exposure to the arts of analysis. They searched the very present competitive conditions. The second group were in effect statisticians who believed the future could be determined from the numbers.

Years later I recognized that these two camps exist today in guessing which way various elections will go and what is the most successful way to manage money.


As a career securities analyst I have never seen a number from which I didn't want more information and data. However, I am not a card carrying member of the statistical clan. The reason I do not claim membership is that I do not think the numbers by themselves provide the answers that I need to generate confidence.

There are two other reasons that I don't wish to fit under the statistician label. The first is historical. In the era when the Dow Jones Industrial Average was being constructed, those hard working clerks in brokerage firms who produced recommendations for investors and whose main source of corporate information were the very thin reports published by companies. These clerks were unable to visit companies or third party sources and were called statisticians. My guess is that my Grandfather's firm had one or more. It was not until the era when Benjamin Graham was going beyond the ratio analyses of annual reports that the term securities analyst evolved.

The second reason I do not want to march under the statistician banner goes further back in history, but is equally important today. Another Benjamin, Benjamin Disraeli the Prime Minister of the United Kingdom in the 19th century is quoted (most often in the US by Mark Twain) as saying "Liars, Damn Liars, and Statisticians" were  the source of bad information and conclusions. I am afraid, particularly this remains true in the political world today. Part of this tarnished label attached to statisticians has to do with polling. Not only did the Brexit polling not capture the true intentions of those in Northern England but that it was followed in Colombia. There were three pre-referendum polls that showed that the no vote in Colombia was between 34 and 38%. The final vote was the "No" vote carried 50.2%. Again the issue has a geographic focus. Most of the No vote was largely rural, which is more difficult and expensive to gather. I am guessing many of the current US polls are similarly flawed.

One of the mistakes some British made is crediting the bookies with analytical inputs. A similar mistake, I believe, is being made on this side of the pond. The believers in the efficacy of these inputs, do not understand that both measures are similar to the pari-mutuel system at the racetracks where the odds are not judged mentally but are calculated by the amount of money bet. Further, my guess is that the northern English farmers and most Republicans in the US are not by nature gamblers, so the weight of money is not representative of the voters.

Turning to our investment world, those that believe in factor investing or other asset allocation dictates are essentially statisticians looking for their "system" as some of their brethren did at the track. Recently JP Morgan Asset Management published a 72 page   "Guide to the Markets®". An analysis of some of its data is as follows:

It has identified seven  major factors; including High Dividend Yield, Small Cap, Minimum Volatility, Cyclical Sectors, and  Momentum. The two best factor portfolios in 2015 were the last and next to last in the first nine months of this year.

Asset allocation funds may have many adherents, however since 2006 in a performance array of ten different types of Fixed Income funds on average they ranked fifth out of ten with two years in fourth place and three in sixth place.

In a similar selection of ten major asset classes from 2000, asset allocation returns were again in the middle on average, with the best in one year getting up to third place and five times in seventh place.

There is a problem with the statistical-only approach. When will the creators of the factors or asset classes recognize the changes in our dynamic markets? If those changes are perceived too late, much of the growth in value will not be achieved. For example, when the four largest global companies in terms of current market cap are recognized with appropriate weights they are all relatively young companies that are still in their first to third  generation of management.  The four are Apple, Alphabet (Google), Microsoft, and Amazon.

Analytical Approaches

A good analyst examines the past statistics to see what items are likely to be absent going forward and/or deserve a different weighting going forward because of a change of conditions. In projecting the future it is also wise to assume some level of intellectual or financial fraud as well as less than perfect executions of plans. In addition one should expect that technology will both help and hurt people's efforts. At one point, it was good analytical practice to calculate eventual scrap value from written off plant and equipment. Today it may actually cost a company to close down and get rid of plant and equipment without a tangible scrap value. In today's fast moving world useful lives may be shorter than the depreciation schedules.

Beyond the analysis of the past what can the analyst use to project the future? To an important extent demographics is destiny. However, the raw numbers have to be modified by changes in social structure and education. The answers may be quite different from work force and consumer market applications. These trends are not just national but global in implications. In turn this suggests that any US investor that does not have approximately half of his or her earnings coming from beyond our borders is not appropriately hedged. However, we already live in a global world where almost every company large or small is benefiting or suffering from multi-national influences. Thus no matter where you pay your taxes, locally based multi-nationals are diversifying the national sources of your investment income without your instruction.

Investment Implications

One of the lessons from the racetrack is that short races are more difficult to get right. The first one out of the gate has a tremendous advantage over the slightly slower. In investing I have noted a similar phenomenon. Catching up is difficult. Thus, at the track and in terms of portfolio management I prefer the longer races where there is time to recover. Therefore, at this point in our history I would like to focus a couple years after the next series of US elections which may not end until 2019. At that point demographics from today's level and mix will be playing out. There will be some major technological changes, hopefully positive.

I am more confident in the run up to my preferred investment horizon, I will rely on the past pattern of periodic and relatively painful declines followed by much longer periods of gains which in total produce a reasonable rate of return for those who are in for the long-term. This philosophy will work until it becomes dangerous because of “fellow travelers’ enthusiasm.”   

Question of the Week: Are you more a Statistician or an Analyst?
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Sunday, October 2, 2016

The Art of Selling Wisely


With the growing evidence of a rising stock market, now is the time to ensure that investors are well schooled in the art of selling some of their stock investments. The market is going up despite that many experienced investors are urging caution. Perhaps one reason is that Credit Suisse, among others believes a President Trump would at least temporarily be good for the market in anticipation of significant infrastructure spending. Regardless of the motivation of the excess of buyers over sellers, prices are rising. Thus, it is the time to remember the law of the market that I heard during one of my first elevator rides at the New York Stock Exchange building when one floor broker asked his companion, "Do you know how to make a small fortune in the market?” The answer was "start with a large one." This quip was the stock market equivalent of the law of gravity. After sustained gains, losses will follow.

Various academics and other pundits devote much of their breath to informing us what and when to buy. Because we have been living in a world since the dark ages of intermittent, but generally rising secular growth, the odds of some success were in favor of the buyers most of the time. However, what counts is not the size of your poker chips at its zenith, but what your winnings are at the end of the game. Further this goal should be measured in after-tax and after-inflation in the currency of choice with appropriate allowance for anxiety suffered during the game.

Sell signals come in different sizes and shapes for different investors. Some are market related. Others are related to specific securities, sectors, or investment policies. Some sell signals are very personal in nature which has to do with changes in the capabilities and conditions of the investor.

Recognizing the Short-Term Power of Upward Stimuli

All stimuli are like the winds of a hurricane and no matter how strong at one moment eventually become docile. A list of some of the stimuli that I expect to weaken in the future are as follows:

  • ·       According  to a long-term stock market analyst who makes sense to me, he is worried that the stock market's next rise will reach the upper limits of a channel that goes back to 1929 and from the next peak will fall precipitously, correcting most of the rise at least to the latest bottom.
  • A decline in the number of buybacks and their impact on stock prices.
  • Friday's last few minutes of market action when the Dow Jones Industrial Average fell more than 40 points to finish the day up 164 points.
  • Almost all economic comments are top down starting with a precise view as to the movement of GDP. For example, Credit Suisse is forecasting a speed up to a growth rate approaching the top of its recent channel. Since the number is small I have been suspicious as to its accuracy which is far too close to its admitted error rate. Now I have some support from an official body. Historically, I have always been impressed by the accuracy of Japanese data. Not necessarily its forecasting ability, but its measurement capability. Now, according to the Financial Times, the Japanese government is rethinking its GDP measure. In one recent period its published GDP figure was a -0.9 % as compared with a newly constructed index based on more current data which showed a gain of +2.4%. Thus the Japanese policy makers have joined the US Federal Reserve Board, Departments of Labor, Commerce and the White House which have demonstrated that they have been flying blind. Our modern societies and economies are much more complex than our budget-starved official statistical organizations.
  •  Globally our very smart policy leaders do not understand our collective realities. This is the main reason that the "experts" around the world were surprised by Brexit. (I was not when I looked at the polling techniques.) Thus, I expect that "experts' will be surprised at various points in the future.
  • In a period of leveling industrial demand as in 2016, non-energy commodity prices are up 30% this year. Another sign of my concerns raised above. All they had to do is to look at one of the oldest measures in an industrial economy, chemical activities which has been strong all year.
  • My final concern is that various political and economics commentators do not understand that no matter who sits in the White House next, they are likely to have at least one down market year in the first term, possibly combined with a recession. If the occupant wants to be renewed they would be wise to bring on the recession in their first year in order to improve the odds by the 2020 election that we are in a strong upturn.

Time to Reduce Position Sizes

One of the reasons that I have constructed the TIMESPAN L Portfolios® is to focus on what should trigger a cutback in equity exposure. Basically, I believe that periods under five years will probably be exposed to at least one year of down markets. If the down year comes late in the period, the portfolio may not have time to recover so it can meet its funding responsibilities. On the other hand those portfolios that are invested in the longer duration Endowment and Legacy periods can tolerate most cyclical declines and have the benefit of secular growth. My rough rule of thumb is that periods of five years or less are likely to be exposed to at least one year when the equity market will decline 25% from its peak. Endowment and Legacy portfolios may suffer as many as three down years in ten and once in a generation a decline of 50%.

Pre-Decline Cutbacks

There are times when a careful investor suspects that there is too much enthusiasm for a security; e.g., Apple* at $130, for a sector; e.g., Housing, or the market S&P 500 20,000 level. Each of these should have triggered some cutbacks. Normally, it is too late to begin to cutback when prices are declining.  An early sign when to begin is the chatter one hears from media or gatherings of smart people.
*I have owned for a long time.

Integrity Gaps

Any time an investor has a question that is not satisfactorily answered which involves an employee, product, or statement one should begin a dismounting process. Accelerate if there is announcement of a breach of integrity. During periods of stress, one should rely on the financial statements. During such periods the biggest trap is price to book value as we are seeing with various troubled financial institutions.

Better Bargains

One of the techniques that the late and great Sir John Templeton, (a consulting and data client), used in managing his various portfolios was to compare a new attractive investment with his other holdings. He drew cash from the least attractive to the new most attractive. This was a way to keep his portfolios fresh with the current market.

Internal Changes

Each investor in a security or a portfolio is in effect a partner with some responsibility. If internal conditions change one or more holdings may no longer be appropriate. For example in our holdings of funds and fund management companies if I (or my Vice President in charge of fund selection) were for any long-term reason not able to supervise these particular investments, the positions should be sold in an orderly fashion. More general positions can probably be well managed by other competent managers and can be retained under their supervision.

The Disposal Process

Up to this point I have left open the choice of immediate sale or size reduction. This decision should be made separately for each transaction. There are two general rules to govern actions. The first is a follow on to Sir John's strategy. The question to be addressed is what are you going to with the proceeds. If an investor does not have a good place for the money, assuming there is not an urgency to sell, reduce the size of the position in an orderly fashion. In absence of any other guide the market on an absolute basis during our lifetime generally moves up. This is not an efficient way or even prudent way to manage money.

The second is a study recently reported in a monthly review by London’s Marathon Asset Management by an independent group. From 1983 through 2006, 2/3 of stocks underperformed the Russell 3000. In addition, 40% of the stocks had negative returns. If an investor did not own the top 25% of the performers over the period the investor’s total return would have been zero. (This is not an excuse to index as most stocks in an weighted index enter after their best years of performance.)

In Conclusion

Matthews Asia has a useful way of looking at portfolio decisions, and I may add business decisions. They divide them between strategic and tactical. Strategic decisions are not expected to change other than a long- term need to fundamentally leave one process to move on to a new one. Tactical decisions can be easily reversed as conditions change and possibly reverse. Strategic are fundamental decisions that are not expected to change except under dramatically different expected conditions. Tactical decisions are more market price sensitive influences.

Bottom line:  selling well is much more difficult than buying well. Take as much time, energy, and intellectual capacity as buying. Selling is always a short-term consideration, but it should be viewed as to its longer term implications.   

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Contact author for limited redistribution permission.